The Government is the Mortgage Market

It's time to ask ourselves a collective question; what have we learned from
the economic chaos caused by a collapsing real estate market, which was itself
caused by government intervention and easy credit? The answer is unfortunately,
an emphatic nothing!

Rather than let the market dictate the appropriate price level of real estate,
our government is seeking to re-inflate the bubble, only this time with fire
and hydrogen instead of just hot air.

It isn't bad enough that FNM and FRE are in a government controlled conservatorship
and own or guarantee over $5 trillion in mortgages. Or that the Federal Reserve
is in the process of buying $1.25 trillion in Mortgage Backed Securities. Now
we have the Federal Housing Administration (FHA) taking up the slack caused
by the lack of faith in the GSEs.

The FHA insures private mortgage lenders against borrower default on residential
real estate loans. These loans are then packaged into Mortgage Backed Securities
(MBS). The MBS are then insured by the Government National Mortgage Association
Ginnie Mae. The FHA is now supplanting the GSEs role in mortgage lending. The
agency is now responsible for 18% of new mortgages up from just 1.8% in 2006.
The FHA now insures $560 billion of mortgages and according to Money
Morning, Ginnie Mae will guarantee over $1 trillion in MBS by the end of
2010. Perhaps the most troubling fact about the FHA is that they only require
a minimum down payment of 3.5%! It's amazing we have not learned the lesson
that we must require borrowers to have more skin the game.

The Wall Street Journal reported that the FHA's reserve fund
dropped from 6.4% in 2007 to about 3% today, putting it dangerously close to
its mandated 2% minimum. And according to The Washington Post,
nearly 90% of all new home loans are funded by the taxpayer up from 30% just
four years ago.

So what have we learned from relying upon; The Community Reinvestment act,
Congress, White House, FED, FHA, GSEs, Ginnie Mae, VA...etc.? The answer is
how to better manipulate the real estate market while placing the tax payers
further in jeopardy. Not only are we on the hook for a staggering amount of
government mortgage guarantees, but the taxpayers are also expected to live
up to their pledge to back the Federal Deposit Insurance Corp. (FDIC), which
will now be responsible for bailing out banks whose FHA-MBS have become a bigger
portion of their assets.

The linchpin for the economy and the stock market is real estate values. If
they continue to drop, banks will fail at an even greater rate and there can
be no healing for the consumer either. But the government now has an increased
interest in propping up home prices because they own or guarantee a significant
portion of real estate-based investments.

This makes the exit strategy for the Fed in removing excess liquidity extremely
difficult and greatly conflicted. Here is what Fed Governor Kevin Warsh said
in a September 25th Wall Street Journal opinion piece, "Nonetheless, I would
hazard the view that prudent risk management indicates that policy likely will
need to begin normalization before it is obvious that it is necessary, possibly
with greater force than is customary, and taking proper account of the policies
being instituted by other authorities." However if they actually raised interest
rates aggressively, it would severely erode the value of those MBS held by
the Fed while greatly increasing the costs associated with owning a home. Concurrently,
it would also dampen the demand for real estate purchases.

The result would be; increased rate of bank failures, a lower stock market,
lower home prices, higher unemployment rates and another severe recession --
which will most likely much worse than one we are hopefully coming out of.
Given that scenario, one has to ask themselves how credible and politically
palatable such a strategy of aggressive interest rate hikes really can be.

But the greater question that needs to be asked and answered is why the government
believes the rate of real estate ownership needs to be controlled in the first
place? While it may be true that home ownership makes for a better community,
it remains out of reach for a certain percentage of individuals. By forcing
ownership on those who cannot afford a home, government creates distortions
and imbalances that cause huge dislocations in the economy.

It is up to the market to decide the percentage of people who should rent
and those who should buy. It is the market who is the arbiter for how much
capital should be allocated to real estate.

Meanwhile, if the government still feels compelled to control markets, why
not seek to boost the productive capacity of our economy and rebuild the country's
manufacturing base. Instead of backing policies that simply reward more consumption
and debt.

With more than 16 years of industry experience, Michael Pento acts as chief
economist for Delta Global Advisors and is a contributing writer for GreenFaucet.com.
He is a well-established specialist in the Austrian School of economic theory
and a regular guest on CNBC and other national media outlets. Mr. Pento has
worked on the floor of the N.Y.S.E. as well as serving as vice president of
investments for GunnAllen Financial immediately prior to joining Delta Global.